The relationship between the finance head and the auditors is often as close as it can be. One is the maker of accounts, the other is the checker of those statements. In the present day world, where businesses are global, complex and extremely dynamic, the relationship between these two actors on the corporate scene is close and it keeps evolving.

In recent cases of fraud, mismanagement and corporate failure auditors have come under fire for having failed to live up to the exacting standards expected of them.

Here in a follow-up to our series on the relationship between the auditor and the CFO, PK Ghose, Former Executive Director & CFO of Tata Chemicals and Advisor to Group Chairman, Tata Group takes us through some of the main issues from the finance head’s perspective. Ghose is a member of the CFO Board which puts forth rational and practical views on making regulation work for India Inc. This is the first of a two-part interview. Edited excerpts:

Q: Do you think the relationship between auditors and CFOs needs to be adversarial?PK Ghose: The CFO’s is fiduciary duty and one of his primary jobs is to manage risk. The auditors are supposed to report on financial statements that should express a fair view to the shareholders, regulators, public and other stakeholders. In my several years experience, I haven’t found the relationship between the auditor and CFO adversarial.

I worked with the Tata group where ethical standards are very high and is at the core of corporate culture. We never had an adversarial relationship with auditor. There can be differences in view that can be settled in discussions but it never happened that auditors were pressurised by the CFO or the management. We always played a proactive role with the auditors and always tried to settle differences amicably, with the aim of bringing out a true and fair view.

These days CFOs tend to buckle under pressure and accept certain changes (in financial statements). They should always ask themselves the question whether they are fulfilling their fiduciary role.PK Ghose

Q: Has the relationship changed in the past few quarters as a fresh series of events has come into focus?PK Ghose: I think there is a trend these days where CFOs have tended to buckle under pressure and accept certain changes (in financial statements). They should always ask themselves the question whether they are fulfilling their fiduciary role. That certainly is a change that has happened over the years.

You can see what transpired in PNB where controls were completely sacrificed. In the case of Jio, accounting treatments can be said to be legal but may not be representing a fair view.

Q: Is this a recent trend that you have seen or this kind of a pressure has always existed?PK Ghose: This is a trend which has been increasing over the years, but the proportions are different (now). Today, it goes beyond minor tweaking of the profit and loss statement and balance sheet.

Q: Any specific reason that you see for this change?PK Ghose: It is difficult to make a generalised statement; you have to see individual cases. But certainly it has lot to do with cut throat competition, the increasing compliance requirements and regulatory overload and the growing incidences of fraud and corrupt business practices.

Q: So let us begin with Jio. The company’s accounts have come under scrutiny for some ‘creativity’. What do you think?PK Ghose: What really are the arguments here? One, there is mention of about six months of expenses being projected versus three month’s income. The second is that there has been huge amount of start-up costs which is not reflected in the financial statements. They have classified almost everything associated with the launch of Jio – be it salary, interest, selling and distribution expenses and so on – as capital expenses.

(Now, let me compare a live example that I had faced. The company was a putting up a new manufacturing unit and you have to disclose when commercial production starts so that expenses which are capitalised hitherto will now be operational expenses. The auditors considered the expenses after a certain date as revenue in nature . Our contention was that commercial production had not started.

Then a strange thing happened. The auditors produced a newspaper item about the plant being inaugurated by a minister in the presence of top officials of the company. According to the auditors, it meant commercial production has started. One cannot be launching a plant without having started commercial production. We had to consider the auditors view and change (our stance) accordingly.)

Now, look at Jio’s accounting. If you compare it with the manufacturing unit, their services had started fairly long ago, but they did not classify it as expenses.

Once your service is functional you are providing that service, it would actually be part of the normal expense charged to the profit and loss account. They postponed this. Therefore, the six months and three months (discrepancy).

The other thing where CFOs and auditors come in is on the depreciation treatment. If one would compare a comparative company in this sector, the depreciation charges are pretty high. The current estimate was roughly one fourth to half of what is charged. Now, the question arises why is it so?

Obviously depreciation and amortisation cost will be low in the initial years. The question certainly arises whether there will be huge write-off charges in the future and how that will be managed by Jio later on.PK Ghose

The spectrum has been amortised on the usage basis rather than on straight line method which is followed by other operatives. So depreciation amortisation depends on the pattern of consumption of expected economic benefits therefore this tantamount to a straight line method instead of a unit depreciation method.

So obviously your depreciation and amortisation cost will be low in the initial years. The question certainly arises whether there will be huge write off charges in the future and how that will be managed by Jio later on.

In the third instance, the entire project cost was phenomenal in Jio – Rs 140,000 crore, but almost Rs 91,000 crore was pumped in as equity and the balance as debt. Now, if you look at the interest cost element, it is substantially lower than what would normally be the case.

Equity doesn’t carry any interest, but in some part of the balance sheet of Reliance there should be some element of cost. Obviously because of the very strong balance sheet of Reliance, the interest cost will be lower. Leaving that aside, the (remaining) interest cost itself is much lower than what one would have expected.

Here comes the role of the CFO and the auditor. Would the auditors classify these as capital expenditure – even when the services have started? If there is a future expected economic benefit then it is in the interest of the general public to know what assumptions they have made.

If these are not disclosed, then this is a black box and if later on they do not achieve what they have projected then obviously there will be implication on the balance sheet.

So it is a question of substance over form. This is where the CFOs would have a major role to play. Legally, they may be fine, but the point is does it present an accurate and fair view of the operations of Jio to shareholders and public.

Q: In this particular case the assumptions are not open to the public. Should the auditor have have come in and mentioned this?PK Ghose: There was newspaper item I saw that (one of) the Big Four has audited their firm, but I am unaware of what their observations are.One would expect that the auditors would insist that their assumptions are disclosed , so that the public knows that if you don’t perform as per expectations or perform beyond expectations, (then) what is the impact on the financial statements.

Q: Legally they are correct. Whose responsibility is greater in this case – the CFO or the auditor?PK Ghose: Rightly speaking the CFO should put this up himself, if he believes that this is the right thing (to do); in case he holds the opposite view, then the more important role will of the auditors to disclose.

It lies equally at both ends as the CFO has the primary role in this, but if the CFO does not (disclose), ultimately it lies with the auditor. One has to keep in mind that Auditors now fall under rotation and every year the auditor’s appointment is renewed. There is always a threat that auditors could be changed.

(The views expressed here are in Mr PK Ghose’s personal capacity and do not reflect the views of the CFO Board).